Re­forms in Jeop­ar­dize

Short of funds but ea­ger to build in­fra­struc­ture, the Fi­nance Min­istry blessed warts of smart alec fi­nan­cial en­gi­neer­ing, no doubt en­cour­aged by some kind of an old boys’ net­work


The eas­i­est way to un­der­stand the cri­sis at In­fra­struc­ture Leas­ing & Fi­nan­cial Ser­vices (ILFS) may be to pic­ture a cu­bist paint­ing by Pi­casso, with all sorts of odd shapes and eyes in­ter­sect­ing in a for­mat in­de­ci­pher­able to the or­di­nary viewer. The dis­cern­ing eye of the highly qual­i­fied critic might see in it a great work of fi­nan­cial art, but, with the gov­ern­ment tak­ing over the board of the be­lea­guered flag­ship of a com­plex group of com­pa­nies — a few of them listed, most not — it is clear that a so-called ‘sys­tem­i­cally im­por­tant’ com­pany (which is a fash­ion­able bu­reau­cratic jar­gon for too-big-to-fail) was play­ing with var­i­ous forms of pub­lic money be­fore the whis­tle blew.

What we see in hind­sight is an em­pire built by tech­nocrats pre­sid­ing over a frag­ile ecosys­tem of con­vo­luted ideas and bloated egos in a state of drift. This turns out to be a so­phis­ti­cated ver­sion of what is the OPM (Other Peo­ple’s Money) game. The ge­n­e­sis of IL&FS’s du­bi­ous glory can be traced to the short­age of funds In­dia felt in the 1980s that after the ush­er­ing in of eco­nomic re­forms gave rise to some sprightly fi­nan­cial en­gi­neer­ing in the 1990s un­der the larger um­brella of pub­lic-pri­vate part­ner­ships (PPP) on the one hand, and the avail­abil­ity of long-term for­eign funds on the other from sov­er­eign or quasi-sov­er­eign in­sti­tu­tions on the other. Ja­pan’s Orix and the Abu Dhabi In­vest­ment Author­ity are among the key share­hold­ers of IL&FS, apart from the Life In­sur­ance Cor­po­ra­tion (LIC).

Short of funds but ea­ger to build in­fra­struc­ture, the Fi­nance Min­istry blessed this ven­ture, no doubt en­cour­aged by some kind of an old boys’ net­work ap­proach. A bunch of tech­nocrats, aided by lead­ing stake­holder LIC, built their own power base on the ed­i­fice of this hunger for growth.

Re­tired ILFS chair­man Ravi Parthasarathy and ousted chair­man Hari Shankaran was among the key movers and shak­ers in this game that has since ush­ered in 169 sub­sidiaries over three decades or so.

It would be in­ap­pro­pri­ate to draw a par­al­lel be­tween the IL&FS cri­sis and the fraud at the erst­while Satyam Com­puter Ser­vices apart from the tech­ni­cal­ity of the gov­ern­ment in­vok­ing com­pany law pro­vi­sions to over­ride its board. At stake in the Satyam case were the wel­fare of em­ploy­ees and the state of cor­po­rate gov­er­nance in In­dia — but there was no sig­nif­i­cant in­volve­ment of tax­payer money or pub­lic sec­tor cap­i­tal or loans.

In the case of IL&FS there may not nec­es­sar­ily have been any fraud in the ortho­dox sense of the term. We seem to be headed for a foren­sic au­dit of sorts — im­plicit if not ex­plicit — at ILFS. The ousted board may have its own case and we might have to choose be­tween the lesser evil of mis­man­age­ment and the greater one of ‘gold-plat­ing’ to hide bal­ance sheet ills. But what is clear is that we had a house of cards built by high-pro­file men and women (and that in­cludes oth­er­wise fa­mous in­de­pen­dent di­rec­tors) pre­sid­ing over a vast em­pire with not much per­sonal skin in the game apart from their own rep­u­ta­tion. Add to this hag­gling about val­u­a­tions and the plans of dif­fer­ent ego­driven bu­reau­cratic of­fi­cials reign­ing over key stakes, and we have a fi­nan­cial thriller with a de­noue­ment that vis­ited them this week as the cen­tral gov­ern­ment cracked the whip.

The new board in con­junc­tion with the Na­tional Com­pany Law Tri­bunal will in ef­fect con­duct an in­quiry. What we see emerg­ing is the out­come of a high­end cor­po­rate equiv­a­lent of com­plex share­hold­ings chas­ing loans whose cash flows did not hap­pen smoothly, re­sult­ing in ugly de­faults.

So who picks up the bill? Take your pick be­tween the pub­lic sec­tor bank de­pos­i­tor, the LIC pre­mium sub­scriber and, of course, the eter­nal tax­payer. Mu­tual funds will have their own warts to show. In pro­mo­ter­driven ‘crony cap­i­tal­ist’ com­pa­nies, it is easy to pin­point con­trol­ling fam­i­lies as erring en­ti­ties.

In this case, the game is more com­pli­cated. What we see is a wel­ter of bonds, loans, de­posits, com­mer­cial pa­pers and other in­stru­ments in­ter­wo­ven in cu­bist mys­tique pro­vid­ing In­dia’s du­bi­ous counter to Amer­ica’s de­riv­a­tives that leg­endary in­vestor War­ren Buf­fett de­scribed ( as the “fi­nan­cial weapons of mass de­struc­tion.”)

Mer­ci­fully and hope­fully for In­di­ans, the rot here may not be that deep be­cause the con­ta­gion may be lim­ited in scope and cush­ioned by a gov­ern­ment bailout and over­haul, although the way non-bank­ing fi­nan­cial com­pa­nies (NBFCs) have been ham­mered in the stock mar­ket shows that sen­ti­ments can be more pow­er­ful than facts.

What­ever the de­tails, the IL&FS cri­sis raises hard ques­tions on how In­dia needs to deal with PPPs for in­fra­struc­ture build­ing. The key point to note is that in­fra­struc­ture fi­nance com­pa­nies end up treat­ing pub­lic goods as if they were pri­vate con­sump­tion items. How­ever, ju­di­cial bat­tles and pub­lic protests by civil so­ci­ety groups and farm­ers in the case of the Noida Toll Bridge Com­pany, the Gurgaon toll plaza, and other projects show that cash flows don’t come easy. Add to this the fact that projects get stalled for var­i­ous rea­sons linked di­rectly or in­di­rectly to ei­ther court cases or gov­ern­ment poli­cies and we get a Pi­casso paint­ing. We saw how power projects linked to coal al­lo­ca­tions and tele­com com­pa­nies linked to 2G spec­trum both caused con­fu­sion and po­lit­i­cal tug­sof-war in­volv­ing the gov­ern­ment’s role.

The NDA gov­ern­ment has smartly made the is­sue po­lit­i­cal. “De­te­ri­o­ra­tion in the fi­nan­cial per­for­mance and sub­stan­tial lever­ag­ing of the IL&FS Group started many years ago on ac­count of stalled projects in in­fra­struc­ture sec­tor largely ow­ing to wrong de­ci­sions and pol­icy paral­y­sis be­fore 2014,” says the gov­ern­ment state­ment jus­ti­fy­ing the su­per­s­es­sion of the IL&FS board. On the ground, we have seen a Ponzi scheme of bor­rowed cap­i­tal be­ing used to com­pound pre­vi­ously bor­rowed cap­i­tal.

With its debt to­talling Rs 91,000 crore and as­sets val­ued at Rs 115,000 crore, on pa­per the IL&FS group seems to have suf­fi­cient net worth, but in­fra­struc­ture as­sets can­not be treated like dis­pos­able in­ven­to­ries as they are pub­lic goods. This is not a fit case for a base­ment sale.

The takeover of the IL&FS board is most wel­come as the buck does stop with the gov­ern­ment in a ven­ture blessed by the state in so many forms since the 1980s. Uday Ko­tak of Ko­tak Mahin­dra Bank has re­placed Deepak Parekh of HDFC as the blue-eyed cor­po­rate trou­bleshooter for the fi­nance min­istry, but an­gels and de­mons dance mixed in this fi­nan­cial soap opera. We need to ask hard ques­tions on how to mea­sure the so­cial out­comes of in­fra­struc­ture projects on the one hand and the tax­payer and pub­lic sec­tor bank costs on the other in a mix of pub­lic sec­tor ap­ples and pri­vate sec­tor or­anges.

We need to ask how pri­vate ex­ec­u­tives can play proxy roles in in­sti­tu­tions that are ef­fec­tively pub­lic in char­ac­ter. We need to find out how as­sets and li­a­bil­i­ties are counted in a sys­tem where pub­lic pol­icy and tran­sient fi­nan­cial bu­reau­crats pre­side over a com­plex, sen­si­tive fi­nan­cial sys­tem in which LIC, the pre­mium payer and the pub­lic sec­tor bank de­pos­i­tor, are un­sus­pect­ing vic­tims. In­fra­struc­ture projects can­not be treated sim­plis­ti­cally but fi­nan­cial onus has to be sim­ple enough in or­der to fix ac­count­abil­ity. It is a tall or­der.

The IL&FS cri­sis is best treated as an op­por­tu­nity to end a PPP mess so that the role of the state and pri­vate sec­tor com­pa­nies are prop­erly de­lin­eated with clar­ity on ac­count­abil­ity at var­i­ous lev­els. We need a mean­ing­ful sys­tem of col­lat­er­als and guar­an­tees to the ex­tent pos­si­ble. Above all, the IL&FS cri­sis shows the lim­its of Smart Alec fi­nan­cial en­gi­neer­ing by em­pire-build­ing tech­nocrats with sys­temic re­spon­si­bil­i­ties dis­pro­por­tion­ate their in­di­vid­ual skin in the game.

IL&FS non-ex­ec­u­tive Chair­man Uday Ko­tak

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